Earnings, Cash Flows and Ex post Intrinsic Value of Equity

This paper examines the relative importance of earnings and operating cash flows in equity valuation. In contrast to previous studies that use stock returns or future operating cash flows, we use ex post intrinsic value of equity as the criterion for comparison. Ex post intrinsic value of equity is determined adopting both the discounted dividend and residual income models with ex post (future) realizations of dividends/residual income over threeand five-year horizons as inputs. The advantage of using the ex post intrinsic measure is that this measure is not contaminated by the stock market’s fixation on reported earnings (Sloan, 1996). Also, unlike future operating cash flows, ex post intrinsic value is a formal and comprehensive measure of the fundamental value of the firms’ equity. Our findings unambiguously indicate that accrual-based earnings dominates operating cash flows as a summary indicator of ex post intrinsic value.